Forrest McDonald, “The Founding Fathers and the Economic Order”

A speech given to the Economic Club of Indianapolis on April 19, 2006. Forrest McDonald is Professor of History at the University of Alabama and has written a number of introductions to Liberty Fund books. In this talk he explores the differences between what
type of economic order founding fathers like Alexander Hamilton
intended to create and the kind of economic order they actually
created.

Copyright 2006 Forrest McDonald.

If I should ask you what kind of economic order the Founding Fathers
contemplated when they established the constitutional order, you would
doubtless reply capitalism or a market economy. If I addressed that
question to a similar number of professional American historians, the
answer would be the same, the difference being that most of you would
add "Thank God" and most of them would add "unfortunately."

In certain important particulars, your answer is supported by the
historical record. For one thing, Americans were committed to John
Locke's proposition that mankind has a God-given right to life,
liberty, and property, and that legitimate governments are required to
protect those rights. In the Constitutional Convention of 1787 James
Madison, Gouverneur Morris, and others listed the protection of
property rights as the primary reason for instituting government; the
sole dissenter was James Wilson.

For a second thing, the Constitution created the largest contiguous
area of free trade in the world. Neither the states nor the Congress
could levy taxes on the interstate movement of goods which the states
had been theoretically able to do prior to the adoption of the
Constitution. For yet another, the contract clause of Article I,
section 10 - "No State shall. . . pass any. . . Law impairing the
Obligation of Contracts" - was a commitment to unfettered capitalism
insofar as it prohibited state legislative interference into market
transactions. Mystery surrounds the contract clause: it was proposed by
Rufus King (who was a delegate representing Massachusetts) late in
August and was roundly rejected. Somehow the clause made its way into
the finished document a couple of weeks later.

As to whether the Framers intended to create a capitalistic
order, the weightier evidence balances to the contrary. Let us start by
considering what they understood by property rights. The appropriate
source is Sir William Blackstone's 4 volume Commentaries on the Laws of England,
a work that James Madison said was "in every man's hand." On the second
page of the second volume, subtitled "Of the rights of things,"
Blackstone defines property as "That sole and despotic dominion which
one man claims and exercises over the external things of the world, in
total exclusion of the right of any other individual in the universe."
Splendid statement, but Sir William devotes the remaining 518 pages of
the volume to qualifying and specifying exceptions to his definition.

Every state had adopted English prohibitions of "offenses against
public trade," which banned usury, regulated the price of bread, and
forbade such practices as "forestalling" (buying or contracting
commodities on their way to market), "engrossing" (buying large
quantities of commodities with intent to sell them in other markets),
and "regrating" (buying and reselling products in the same market).
Americans, like Englishmen, also recognized that their right to acquire
and hold private property was subject to rights residing in the public.
As an aggregate of individuals, the public retained rights to grazing,
wood gathering, hunting, passage, and water use on privately owned
lands. In its corporate or governmental capacity, the public reserved
the right to restrict the use of private property and even take it from
the owners in certain conditions.

These legal barriers were reinforced by ideological considerations.
Granted, Americans were, by and large, a practical and not an
ideological people, but they had embraced a pair of ideas that took
deep roots. First was republicanism. When Americans proclaimed their
commitment to republicanism as part of the reaction against George III
in 1776, most did so willy-nilly without knowing what it entailed. The
body of literature on the subject was large and readily found, however,
and soon public figures were versed on the subject. The actuating
principle of a republic was public virtue, virtue meaning manly
devotion of one's self to the wellbeing of the public. The opposite of
virtue was vice, meaning effeminacy, or a love of luxury.

The very idea of economic growth that inheres in a market economy
was incompatible with this primary principle of republicanism. Plato,
believing that relative equality of property is essential to a
republic, proposed to limit inheritances and recommended that no
republic be established on the sea or on a navigable river, for that
"would expose it to the dangers of commerce" and the inequalities that
resulted from trade. Lycurgus, "in the most perfect model of government
that was ever framed," ancient Sparta, had forbidden trade altogether.
And Montesquieu, whom American devoutly admired, declared that if
people were allowed "to dispose of property [as they] pleased," a
republic would be "utterly undone." As disparate a pair of Americans as
John Adams and Benjamin Franklin agreed. Adams denounced credit as
responsible for "most of the Luxury & Folly which has yet infected
our People," and declared that anyone who could devise a way to abolish
credit forever "would deserve a Statue to his Memory." Franklin
characterized commerce as "generally cheating" and wrote bitterly of
its corrupting and debilitating effects.

The second ideological barrier arose from the agrarian tradition and
the accompanying mystique of the land. You have heard Jefferson's
quotation - isnt it on the Jefferson Monument in Washington? - "those
who labor in the earth are the chosen people of God if ever He had a
chosen people." That attitude was widely shared in l8th century
America, and so was Jefferson's comment that "the mobs of great cities
add just so much to the support of pure government as sores do to the
strength of the human body." These prejudices found expression in
assorted ways, including the ubiquitous landed property qualifications
for voting and office holding, which insured that agricultural
interests would dominate government at the expense of commercial,
manufacturing, and financial interests.

Moreover, the agrarian tradition impeded economic development in an
explicitly anticapitalist way. Its most vituperative and generally
accepted version was that formulated by Henry St. John, First Viscount
Bolingbroke, and his circle of English Tory friends. Bolingbroke had
led the opposition to Sir Robert Walpole (the first "Prime Minister")
who guided the Financial Revolution during the l720s and l73Os that
transformed England into a modern capitalistic state by monetizing the
public debt. Bolingbroke glorified landowners and castigated "money
men," coining a litany of opposition to capitalism that warped the
perspective of Americans as they imbibed it and infected them with a
"paranoid political style."

Perhaps it appears that you can't get to the modern world from
there. But notice that my original question was not what kind of
economic order the Founders established, but what kind of order they
contemplated establishing. Had I phrased it the first way, you (and the
historians) would have been right. What I have been talking about was
what the Framers contemplated. What they actually did was something quite different.

Thus far I have left two crucial considerations out of account. I
have spoken of private property, but the Revolutionary War resulted in
the United States collectively owning huge amounts of public
property, in the forms of public lands and public debts. Before the
Revolution vacant land belonged to the Crown except in the proprietary
colonies of Pennsylvania and Maryland. Now the western lands,
consisting of millions of acres, belonged to Virginia, North Carolina,
and Georgia in the South and to the United States government in the
north. The public debts (not counting $10 million owed the King of
France and various Dutch bankers) totaled $65 million. The public lands
were worth far more than all private lands combined, and the public
debts (owned by a large number of citizens) amounted to more than all
the commercial property in the country.

The common view was that the public lands should be sold to raise
the money to pay off the public debts. That course was already being
followed, after a fashion. Several groups of speculators contracted
with Congress or state governments to buy vast tracts payable in
installments with public securities at par value - a bargain for the
speculators, inasmuch as the securities could be bought on the open
market for ten or fifteen cents on the dollar.

At this point the second consideration I left out comes into play,
namely Alexander Hamilton. Hamilton's ruling passion was the love of
Fame: an obsession with achieving immortality through the grateful
remembrance of posterity by being the Lawgiver, in the tradition of
Lycurgus of Sparta and Solon of Athens, who "transmits a system of laws
and institutions to secure the peace, happiness, and liberty of future
generations." No small number of Hamilton's contemporaries shared that
aspiration, but they saw it in relatively narrow terms, meaning the
creation of a balanced constitution that would ensure the people's
safety and liberty. Hamilton sought nothing less than to make over the
people themselves.

Hamilton thought that his country was kept from being a great
nation, indeed kept from being a nation at all, by the inertia of a
society whose pervasive attributes were provincialism and lassitude.
Provincialism was reinforced by habit and by interest, but in each
state and every region its main prop was an oligarchy. The distribution
of wealth in America was more nearly equal and society was more nearly
fluid than in the Old World, but status and substantial wealth were
vested in a handful of intermarried families that were essentially
closed to newcomers. Now, Hamilton had nothing against a hierarchical
and deferential social order; he was the politest of men (except when
it came to Aaron Burr). But he vehemently abhorred dependency and
servility, for these were contrary to his idea of manhood. Moreover, he
hated the narrow provincialism that the American order both nourished
and fed upon; and he resented, as only an outsider can, the clannishly
closed quality of the system.

The system also discouraged industry - in the sense of selfreliance
and habitual or constant work and effort - by failing to reward it.
Status derived not from the marketplace, where deeds and goods and
virtues could be impartially valued, but from birthrights. More
precisely, status rested upon personal relationships which rested upon
family connections which in turn rested upon owning land and upon the
mystique that land was the source of wealth and virtue. In other words,
the agrarian mentality of Thomas Jefferson was well-nigh universal in
America. The work ethic prevailed only among a tiny minority. And
though there was little poverty in America, there was also little
industry - and lots of sloth, indifference, drunkenness, and
dissipation. To Hamilton, this was anathema because of its inherent
injustice and because, in his eyes, it made the nation weak and
despicable.

His audacious, self-appointed mission was nothing less than to
remake American society in his own image. By 1786, after reading
Jacques Necker's treatise on the finances of France and Sir James
Steuart's book on political economy, he conceived a means of
accomplishing that revolutionary change. What distinguished the
diligent few was that they measured worth and achievement in terms of
money, whereas the majority disdained money and made do with a
cumbersome system of personal obligations, barter, and fiat credit. To
transform the established order, to make society fluid and open to
merit, to make industry both rewarding and necessary, what needed to be
done was to monetize the whole. For money is oblivious to class,
status, color, and inherited social position; money is the ultimate,
neutral, impersonal arbiter. Infused into an agrarian society, money
could be the leaven, the fermenting yeast, that would stimulate growth,
change, prosperity, and national strength.

The first step in the process, after the Constitution had been
ratified and Hamilton became Secretary of the Treasury, was to devise a
means of establishing public credit. Credit entails credibility,
believability, trust; and the United States had none. Hamilton
addressed his efforts to the ultimate source of credit, the market.
Rather than attempting to pay off the public debts in a short
time (something quite beyond the nation's capacity), he proposed to
consolidate state and national debts and "fund" them, which is to say
provide funds for making regular interest payments but leave the
question of retiring the principal - whether soon, late, or never - to
the discretion of government. In addition he proposed the creation of a
sinking fund, consisting of surplus revenues and the proceeds of a new
loan in Europe, which would be used to buy government securities on the
open market. The sinking fund's key function was to engage in
openmarket operations aimed at bringing the prices of public securities
to par. Once that was done, the investing public would be convinced
that public credit had been established, and when investors believed
that public credit had been established, it would ipso facto be
established. Hamilton's proposals were enacted into law. As a
consequence, certificates of the public debt, heretofore a politically
divisive and economically crippling national burden, were transformed
into capital. Moreover, capital was created into the bargain; the
market value of the paper before Hamilton took office late in 1789 had
been less than $15 million; a year later it was about $45 million. And,
taking care of the public debts left the public lands a wholly free and
clear blessing for the nation.

The next step in Hamilton's grand plan was to create a national
banking system. Originally, he had wanted to monetize the public debt
directly - that is, to have it circulate as money - but the terms of
the congressional act made that difficult. Accordingly, Hamilton used
the securities as the basis for currency rather than as currency
itself, in the form of subscriptions to the capital stock of the
national bank. The bank's notes would circulate equally with specie as
currency. Paper was supporting paper, but this was not financial
trickery as the Jeffersonians charged. Hamilton perceived that -
monetary theorists to the contrary notwithstanding - money is whatever
people believe is money and will voluntarily accept as money.
Underlying his thinking was the realization that the United States, as
a raw and undeveloped land, was long on potential natural wealth but
short on institutional wealth, meaning liquid capital. He therefore
regarded as desirable any stable and orderly means of increasing the
money supply, within the limits of what could be efficaciously employed
in developing the natural wealth. In essence, he was creating the
machinery whereby the nation could be built on credit, financing its
economic development not out of savings but out of the expectation of
future profits.

Hamilton built on some of the arguments Adam Smith developed in Wealth of Nations but
rejected Smith's doctrine of noninterference in its broadest sense. He
recognized - as later economic theorists befogged by Marxism failed to
do - that social values and habits dictate economic activity, not the
other way around. "Experience teaches," he wrote, "that men are often
so much governed by what they are accustomed to see and practice, that
the simplest and most obvious improvements, in the most ordinary
occupations, are adopted with hesitation, reluctance, and by slow
gradations." Men would resist change, he believed, so long as even "a
bare support could be ensured by an adherence to ancient courses." The
natural order was for social habits to dictate economic norms and for
government to reflect the interplay of the two. Hamilton saw the
advantage of using government to bring about economic changes that
would in turn alter society.

While rejecting laissez faire, however, he was emphatic in his
commitment to capitalism. Primarily that commitment was moral, not
economic, for Hamilton believed that the greatest benefits of
government-encouraged private enterprise were not material but
spiritual, the enlargement of the scope of human freedom by expanding
the opportunities for human endeavor. "Minds of the strongest and most
active powers," he wrote, "fall below mediocrity and labour without
effect, if confined to uncongenial pursuits. And it is thence to be
inferred, that the results of human exertion may be immensely increased
by diversifying its objects." In its own right, to stimulate the human
mind was a distinct good. "Every new scene, which is opened to the busy
nature of man to rouse and exert itself, is the addition of a new
energy to the general stock of effort. The spirit of enterprise, useful
and prolific as it is, must necessarily be contracted or expanded in
proportion to the simplicity or variety of the occupations and
productions, which are to be found in a Society."

And so we return to the original question. Did the Founding
generation contemplate the creation of a capitalistic, free-market
economy? No, the majority did not. Had the will of the majority
prevailed, had the Jeffersonians prevailed, had those committed to pure
republicanism prevailed, the United States would have remained an
agrarian, colonial economy destined to become a collection of banana
republics. Fortunately, a handful of like-minded visionaries working
through Alexander Hamilton and his office as Secretary of the Treasury
used the freedoms of the Constitution and its protections to create a
capitalistic, free-market economy and ensured that the United States
would become the richest, most powerful, freest country the world has
ever known.